Contract, Specification and Quantity surveying Chapter 5

CHAPTER FIVE: PROJECT COST ESTIMATION AND VALUATION

5.1. Introduction
• Project Cost estimation is the process of valuing on monetary expression, including the cost
of all possible entrants necessary for the planning, implementing and monitoring stages of
the proposed project under consideration.
• Cost estimation is the determination of the probable cost of a project.
• Project Cost includes:
o Preliminary investigation (project appraisal costs)
o Design and supervision (consultancy cost)
o Construction works (contractor’s cost)
o Land owning cost, and
o Monitoring costs
• An estimate serves a number of different functions, depending on the stage of the project, as
shown below:
o Feasibility: Initially feasibility of the project need to be determined ➔Feasibility Estimate
(Conceptual).
o Schematic Design (Conceptual design): Sketches are prepared. Major elements are defined
➔Use a preliminary method to estimate cost. Cost of each element is established (cost
plan).
o Design Development: Progressively the scope of the project is defined ➔A series of
preliminary estimates are done during this phase to assure adherence to cost plan.
o Contract Document: Finalize drawings & Specifications:
➔Designer’s estimate to anticipate and check contractor’s bid prices.
o Bidding Phase: ➔Contractors prepare detailed estimate to submit bids.
o Construction Phase: ➔Estimates are prepared for cost for cost Control and for change
order evaluations.
Feasibility Estimate (Conceptual Estimate)
• Needed to make decision go/no go with project
• Costs include:
o Land

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o Financing cost
o Consultations/Studies
o Engineering
o Project Management
o Construction
o Operation & Maintenance
Preliminary Estimates and Cost Planning
• The Conceptual Estimate found during feasibility becomes the initial project budget
• Subsequent design development should remain within the limit of this budget
• For that purpose, several preliminary estimates are performed as more details become available
through the design.
• Preliminary estimates assign cost to various assemblies (elements) of the project (Cost Plan).
{substructure, superstructure, interior partitions & doors, exterior cladding ..etc.}
• Preliminary estimates allow for Value Analysis – Compare value of an element with its cost
➔Consider alternatives ➔Select desired option.
• Over all the main purpose of cost estimation can be summarized as follow:
o know the volume of work in reference to the fund available
o determine actual cost per unit of item
o identifying engineering estimate of the work for bidding purpose
o work out economical use of materials, labor and equipments
o in cases of variations to determine the extra cost to be incurred
o when there is escalation, to work out the escalation in cost
5.2. Information required for cost estimation
• The following information is required to define cost per unit of work
o Correct information of the market price of the materials at the time of need to be used as
a basic price
o Correct information of the rates of various categories of skilled and unskilled laborers as
wage rates to be used for daily work rate
o Output of laborers per day for various types of items (productivity)
o Correct information of the rates of various categories of equipments and tools as rental
rates to be used for major items of rates

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o Up-to-date knowledge of the construction methods.

Factors Affecting Cost Estimation
• Factors which affect the cost estimation are summarized as follow:
o Type and documentation of the project
o Construction scheduling
o Bidding environment
o Quality and availability of material and labor (given in specification)
o Construction facilities /tools and method of construction
o Location of the site: Transportation charges
o Proper management
o Land charges (lease)
o Nature of subsurface condition
5.3. Types of Costing or Estimation
• Estimation can be broadly classified as preliminary (approximate) and detailed.
Preliminary /approximate costing
• This type of cost estimation is required to know the financial position of the client before costly
detailed designs are carried out.
• Such estimates are based on practical knowledge and cost of similar previous works. Examples
of approximate cost estimations are as follows:
A. Cost per functional unit
 Hospital =cost per bed,
 Dormitory = cost per student,
 Cinema or theatre = cost per seat,
 residential buildings = cost per area,
 road works = cost per kilometer length,
 culverts or bridges = cost per meter span,
 water supply or sewerage projects = cost per head of population.
B. Plinth area method – cost per m2
• Based on Plinth Area- roof area or external dimensions at the plinth level (Courtyard & open
area shall not be included)

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• The rate per meter square is deduced from the cost of similar building projects in the locality.
C. Cubical Content method – cost per m3
• Based on cubical contents of various buildings, i.e. Plinth area of the building x height x cubic
content rate.
• Height should be taken from the top of flat roof (or halfway of the sloped roof) to the top of
concrete in foundation.
Detailed Cost Estimate (Based on Item Rate)
• This is the most reliable and accurate type of estimate.
• The quantities of items are carefully prepared from the drawings and the total cost worked out
from up to date market rates.
• A detail cost estimate thus requires:
o Quantity surveying and
o Analysis of the different rates for the quantities prepared.
Fundamental approach to construction cost Estimation
• Efficient construction cost estimates shall address properly the required project quality, time
for completion of works and of course the construction cost of the project.
• In deciding to participate in the intended project tender, the contractor shall carefully assess
the impact of the following key factors:
o Type of project
o Method of tendering
o Type of construction contract
o Number and progress of contracts already at hand
o Resource availability i.e. skilled manpower, plants and machineries
o Financial position
• Once decision is made to participate in the intended tender, the contractor shall give due
attention to the following major items listed below
o General and particular conditions of contract contained in the bidding documents
o Technical specifications
o Drawings
o Estimated bill of quantities
o Method of measurement

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o Supporting documents such as information regarding geological formations and

hydrological data
o Site visits
o Construction method statements
A. General and particular conditions of contract
• Proper understanding of the general and particular conditions of contract is mainly important
for construction cost estimation in identifying the responsibilities and cost implications on the
project
o Amount and type of performance security
o Amount of advance payment and type of advance repayment guarantee
o Time for completion of the whole project
o Limit of liquidated damages
o Retention money
o Claims and disputes settlement
o Price escalation
o Tax exemptions
o Insurance of the works
o Owner’s risks
o Applicable laws
B. Technical Specification
• Technical specifications specify the following crucial information to the contractor and it is
the sole basis both for the construction methods to be adapted and the construction cost of the
project.
o Quality of materials
o Quality of machineries and plants
o Quality of workmanship
o Erection and installation methods
o Test and inspection requirements and methods
• Technical specifications basically have restricted applications, which usually define specific
work items. Therefore, for a better understanding and cost estimation of the project, the
contractor must check the given specifications for:

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o Technical accuracy and adequacy

o Define and clear stipulations
o Fair and equitable requirements
o Formats which can be easily used during bidding and construction
o Legal enforceability
C. Drawings
• The contractor mainly understands from the drawings what type of construction methods to be
adapted during cost estimation as well as construction of the project.
• some of the construction methods which need to be addressed during cost estimation of this
building project are:
o Concrete production
o Concrete transportation and placement
o Transportation of construction materials to different floors
o Methods and type of scaffolding
o Types and methods of shuttering works
o Erection and installation of glazing works
o Temporary access for manpower working at different floors
o Skilled manpower requirement
D. Estimated Bill Quantities
• Estimated quantities of work are also the basis to determine the type and number of resources
to be deployed during construction of the project.
• Moreover, construction methods shall be selected in such a way the given quantity of works
can be executed during the completion time of the project.
• Based on the estimated quantity of works, the contractor shall decide the method of
construction to be adapted during executing of the project such as:
o Type and size of crushing plants
o Type and size of mechanical mixers or batching plants
o Type, size and number of machineries such as dozers, graders, loaders, rollers, dump trucks
and so on.
o Skill and number of manpower requirement
o Type and quantity of construction materials, and so on

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E. Supporting Documents
• Supporting documents such as geological formations, hydrological data and other technical
reports like socio-economic studies are usually provided by the owner to contractors for their
own interpretations for heavy construction projects.
• Therefore, the contractor shall have the technical ability and experience in interpreting the
technical data provided to determine construction methods to be adapted which directly affects
the construction cost estimates.
F. Site Visit
• In order to prepare competent and reasonable construction cost estimates, the contractor must
visit the project site unless the site is familiar to the contractor with previous reliable site
information.
• Site visits are critically important especially when the contractor is working with heavy
construction project cost estimates such as road works and hydropower projects.
• The contractor shall prepare his own checklists during the site visit which shall address, but
not limited to, the following issues which have direct impact on the construction costs of the
intended project.
i. Location of the site:
• It helps to determine the mobilization and demobilization costs.
• It also helps to determine the transportation cost of materials from main material suppliers.
• Availability and expected wages of daily labors can be fairly estimated based on the location
of the site.
• Site location also helps to determine the type of camp facilities required to be constructed such
as project offices, living areas, food accommodations and so on.
• Having proper understanding of site location and local weather condition helps the contractor
to determine salaries and benefits of staffs, skilled manpower and daily laborers.
ii. Location of local construction material
• The contractor shall identify the location and quality of local construction materials such as
quarry area for gravel production, sand, selected material, water as well as sub base and base
course materials in the case of road projects.
• Moreover, the contractor shall have the general understanding of the site layout for different
plants such as batching and crushing plants.
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iii. Access Roads

• Site access roads to the main works, quarry areas, water supply, sand, and the like shall be
identified which incurs additional construction and maintenance costs. These costs are
extremely high, in case of heavy construction sites such as road works, hydropower projects
and so on.
iv. Water and power supply
v. Communication facilities
vi. Environmental protection
vii. Existing facilities
F. Method of measurement
• Contractors shall thoroughly understand the method of measurement incorporated within the
bidding documents before starting any cost breakdown calculations.
o BaTCoDA Technical specification and method of measurement
o ERA standard specifications
o Civil Engineering Standard Method of Measurement (CESMM)
G. Construction Method Statements
• Construction method statements give the clear picture of each project activity execution during
the construction phase of the project.
• The required quality of works as per the specifications, estimated quantity of works, safety
standards, as well as time for completion are the sole basis in determining the construction
method statements of a project.
• Construction method statements shall clearly indicate the following crucial construction issues:
o Skill and number of manpower required
o Type and specification of equipments required
o Quantity and quality of materials required
o Proposed working crews
o Estimated crew productivity
o Estimated duration for completion
o Expected defects and remedial measures

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5.4. Basic Cost Components of a construction project

• Basically, the cost of any construction project comprises
o Direct costs, which include the direct cost of materials, labor as well as equipments and
o Indirect costs, which include but not limited to head office and site overhead costs.
A. Direct Construction Cost
• Direct construction costs are all costs that can be specifically booked with an activity in a
project.
• The current trend is to assign as much as possible costs to direct costs as these costs can be
budgeted, monitored and controlled far more effectively than the indirect costs.
• The direct costs mainly include material, labor, equipment and subcontract costs as described
below.
o Direct material costs – These costs referring to the cost of materials, consumables and
components used for executing an activity including the allowances for scrap and wastages.
o Direct labor costs – All costs related to the workers working on a specific activity such as
carpenters, masons, erectors, painters, plumbers and so on.
o Direct equipment costs – These costs referring to the costs of machineries and plants used
in executing a specific activity.
o Subcontract costs – In case some specific activities are subcontracted, the subcontract price
will be considered as the direct cost of the activities to be executed by the subcontractor.
B. Indirect Construction Cost
• Indirect construction costs are all costs, which cannot be directly booked under a specific
activity in a construction project but required to keep the whole project operational.
• These costs are also called overhead costs, which mainly include the head office and site
overhead costs.
i. Head office overhead costs
• Head office overhead costs are all costs required to run the whole operation of the construction
company, which usually administers different projects at a time.
• These costs are not usually associated with specific project but rather shared proportionally by
all projects under the company.
• Some of the checklists for head office overhead costs are given below with further
clarifications.
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• Senior management costs – These refer to costs related with salaries and benefit packages of
the senior management in the head office.
• Indirect labor costs – Staffs other than the senior management members working at the head
office such as the technical, administrative, marketing, finance and supply staffs.
• Head office building costs – In both cases, costs are incurred in such a way either rental costs
will be paid, if the building is rented and building depreciation will be considered, if the
building is owned.
• Bidding Expenses – These costs are usually associated with bid document purchases, site visit
expenses, bid bonds and so on. These costs are sometimes called sunk costs.
• Expertise service costs – These costs will be incurred when professional services are required
such as the services of external auditors, lawyers, management consultants and external
trainings.
• Office furniture and equipments – Different office furniture and equipments are required
depending on the size and standard of the company.
• Office running expenses – The head office operation requires lots of miscellaneous expenses
such as telephones, fax, internet services, stationery, mail services and so many others.
• Workshops, garages and warehouses – Costs related to central workshops, garages and
warehouses such as the depreciation costs of the buildings or rental expenses.
• Bank charges – It is very natural that companies may borrow money from banks. Therefore,
the interest to be paid on the borrowed capital shall be considered under the head office costs.
• Insurance charges – Employees medical insurance, office building and small vehicles
insurance.
• Transportation and travel expenses –costs related to transportation, per diem and living
expenses.
• Sundry expenses – These are miscellaneous expenses such as advertisement expenses,
reception parties and donations.
ii. Site overhead costs
• Site overhead costs are all costs required to run the whole operation of a specific construction
project at site level.

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• These costs are not associated with specific activity in a project but rather shared proportionally
by all activities within the project. Some of the site overhead costs are listed below with further
clarifications.
• Site management costs – These costs refer to costs related with salaries and benefit packages
of the site management members in the project site.
• Indirect labor costs – salaries and benefits of staffs other than the site management members
working at the project site such as site engineers, office engineers, administrative and finance
staffs, data collectors and so on.
• Mobilization and demobilization costs –These costs are mainly transportation costs.
• Tender Expenses – These costs are related with the costs of the contract performance security,
advance repayment guarantee, contractor’s all risk insurance, insurance of the works and third
party insurance depending on the contract conditions agreed.
• Site offices –site offices are constructed from different materials such as corrugated iron sheets,
prefabricated materials, material packing steel containers, steel structure and normal hollow
concrete blocks.
• Expertise service costs – These costs will be incurred when professional services are required
at the project site such as lawyers, claim experts and so on.
• Office furniture and equipments – Different office furniture and equipments are required
depending on the size and location of the project.
• Office running expenses - The site office operation requires different expenses such as
telephones, fax, internet service, mail service and stationery.
• Radio communications - If the coverage area of the construction project is vast, hand held and
stationed radio communications may be used within the site and with the head office.
• Camp facilities – The costs of construction and operation of other facilities such as restaurants,
recreational centers and playgrounds are also included under the camp facilities.
• Access roads – Depending on the topography and location of the project site, different access
roads may be required to construct such as detour roads, access roads to quarry and disposal
areas, etc.
• Water and power supply – All the site offices, camp facilities, the construction itself requires
water and power supply for operating the whole project properly.

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• Workshops garages and warehouses, Bank charges, Transportation and travel expenses,
Insurance charges, etc…
C. Risk Allowance
• Usually contractors incorporate risk allowances in their tender prices to compensate the
negative impacts of different risks such as contractual, technical, political and economic risks.
• Contractual risks are usually stemming from the contract agreements with the project owner,
subcontractors and suppliers.
• Technical risks are associated usually with the clarification of the technical specifications,
working drawings, construction technology and difficulties in understanding new method of
constructions.
• Political and economic risks reflect the impact of political situations, stability of economic
policies, inflation and price escalation on the execution of the intended construction project.
D. Profit and Income Tax
• construction projects are executed by contractors whereby these contractors will commit to
invest their capital to get maximum possible profit from the contracts to be performed.
• A profit margin entirely depends on the market competitiveness and company strategies.
• Any construction company operating a profitable business in Ethiopia shall pay 30% of its
gross profit as an income tax as per the income tax proclamation No. 286/2002.
• If the contractor is registered for VAT, which is usually the case, the contractor’s construction
cost estimate shall also include Value Added Tax which is 15% of the tender amount in
accordance with the Value Added Tax proclamation No. 285/2002.
5.5. Unit Rate Analysis
• Rate Analysis is the process of fixing cost per unit of measurement for the different item of
works.
• Total cost per unit of work (TC): Direct cost (DC) + Indirect cost (IC)
• Direct Cost (DC) includes cost due to material (MC), cost due to labor (LC), cost due to
equipment (EC)
• Indirect Cost (IC) covers overhead costs, and contractor’s profit.
• In order to facilitate estimation Material break down is essential
• Different formats, Excel sheets and software (like CONMIS) are used for rate analysis.

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• It is advisable that contractors shall adapt suitable construction cost estimation formats which
enables to see all the detailed cost breakdowns of the required:
o Direct materials,
o Labor and equipment
o Head office and site overhead costs,
o Risk allowances,
o Profit,
o Income tax and
o Value Added Tax (VAT) or Turnover tax (TOT).
• construction cost estimation formats and procedures shall also serve as the basis for different
purposes as listed below in managing the project during construction.
o Construction planning
o Project cash flow preparation
o Productivity data collection
o Material consumption data collection
o Construction monitoring
o Performance evaluation and controlling
o Performance related pay
o Subcontractor’s price evaluation
o Variations and claims substantiation
o Remedial measures and improvements

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I. Direct Material Unit Cost (E)

• Direct material cost is the total cost of construction materials required to execute a unit of
specific activity in a project.
• In estimating the direct material cost, the contractor shall obtain the quantity and quality of
materials required to produce the specific unit of an activity

• In order to have a better material cost estimation, contractors shall develop their own material
price database and the database should contain, but not limited to, the following information:
o Material price at place of delivery
o Supplier’s address such as telephone, fax and mail address
o Supplier’s contact person
o Supplier’s email address and web site
o Supplier’s credit facility
o Country of origin
o Material delivery time
o Place of delivery such as at the supplier’s shop, project site, Addis Ababa airport or
Djibouti port
o Transportation charges usually per ton-km as well as transporters
• the contractor shall add the following costs to the material supplier’s price to get the material
unit cost at the project site:
o Loading expenses at the supplier’s place of delivery
o Transportation costs to the project site
o Insurance charges during transportation to the project site
o Unloading expenses at the project site

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• Unless otherwise stated on the contract conditions and investment incentives, contractors shall
add the following costs, but not limited, to the CIF Djibouti price to get the final material unit
cost at the project site.
o Port clearance
o Duty
o Excise tax
o Value Added Tax
o Customs clearance
o Clearing Agent’s fee
o Transportation cost from Port to the project site
o Insurance, if required, during transportation
o Unloading expenses at the project site
Example: Assume the CIF price at Djibouti Port for Re-bar is 4,115.53 Birr/ton

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II. Direct Labor Unit Cost (F)

• In calculating the direct labor cost, contractors need to calculate the direct labor hourly cost
which is the total hourly cost of labor crew required to execute a specific activity in the project.
• In estimating the direct labor hourly cost, the contractor shall obtain the:
o Number of labors,
o Skill and labor utilization factor (UF)
o Labor basic salary and
o Labor index from his previous records and the labor market.

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• Labor index is a multiplying factor of the basic salary which represents the additional benefits
whereby a worker gets from the contractor such as:
o Severance pays
o Annual leave
o Occupational accident expenses
o Occupational disease expenses
o Overtime pays
o Occupational safety, health and working environment
o Benefits resulting from collective agreements
Labor Index Calculation

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III. Direct Equipment Cost (G)

• In order to calculate the direct equipment cost, contractors need to calculate the direct
equipment hourly cost which is the total hourly cost of equipment crew required to execute a
specific activity in a project.
• In estimating the direct equipment hourly cost, the contractor shall obtain
o The number of equipments,
o Capacity and equipment utilization factor (UF), and
o The equipment hourly cost.

IV. Site Overhead Cost (I)

• It is easier to express the site overhead costs as a percentage of the direct unit cost of an activity.

V. Head Office Overhead Cost (J)

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VI. Risk Allowance (L)

• Let’s assume the following factors represent the percentage cost increment of each cost
component and the risk allowance will be calculated as follows:

VII. Gross Profit (M)

• As an illustration, if the net profit margin is assumed to be P% of the breakeven cost (direct
costs + indirect costs + risk allowances), the gross profit (net profit + income tax) can be
calculated as follows, which is X% of the breakeven cost.

VIII. Total unit price without VAT

• If the contractor is registered for VAT but the contract is VAT exempted, the contractor’s unit
price in his tender is the sum of direct unit cost (H), indirect unit cost (K), risk allowance (L)
and gross profit (M).

IX. Total unit price without VAT

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5.6. Introduction to Project Valuation

• Individual universally exercise daily the art of valuation without realizing that, each exchange
of property, of what so ever nature and character, involves an appraisal which at least is an
elementary valuation.
• Each exchange of property involves an estimate of the relative worth of the item exchanged.
• In ordinary trade, value is estimated by the utmost instinctive decision that the price quoted is
fair or unfair.
• Valuation in general is defined as the art of estimating the fair monetary measures of the
desirability of ownership of specific property for specific purpose.
• For each property the value must be expressed in terms of some recognized medium of
exchange, usually in the monetary units of the country in which the property is located.
• In most uses of the term “value” as applied to property is a sense of worth, a desirability of
ownership or possession or the exchangeability of property as it can be measured in terms of
money.
• The fundamental basis of the value of any specific property is the present worth to the present
owner or to the would-be purchaser or the probable future service expected from the property
during its probable future productive life in service.
• Valuation is altogether different from costing, because value is an assessed worth of an asset
in context of specific purpose and at particular period of time.
• Valuation is purpose oriented and time frame related exercise.
• Costing is qualitative; it is an exact science; where most of the parameters are well defined viz.
material cost, transportation cost, labor cost, administration etc.
• Value dependent factors: Property value differs according to the following factors:
o Value depends on place, time, circumstances and purpose
o Economic solicitations such as depressions and boom
o Supply and demand
• Essential qualification for value: In order that a commodity can have value, it must possess
three essential qualification:
o It must possess utility
o It must be scarce

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o It must be transferable or marketable

Various definition of value
• Market Value. Market value is the value established in a public market by exchanges between
willing sellers and willing buyers.
• Replacement Value. Replacement value refers to that of a property determined on the basis of
what it would cost usually at the current price level to replace the property or its service with
at least equally satisfactory and comparable property and service.
• Real value or value to the owner. It envisages the intrinsic value to the owners as long-term
investment rather than the immediate realization which is characteristic of market value.
• Liquidated value. It is an estimate of the sum, which the holder of the shares would be expected
to receive in the event of the company being voluntarily wound up.
• Speculation value. Some properties have future secret prospects, if one visualize it. This is
referred as speculative value.
• Forced sale Value. When the owner is forced to sell the property due to the urgent and absolute
necessity, this value is called forced sale value.
• Reversionary Value. It is the value of an asset to the owner after the expiry of lease period.
• Book Value. It is value of an asset as shown in accounts book. This is value on that particular
day arrived by deducting total depreciation till date from its value on the date of its purchase.
• Depreciated value. This is equal to the book value theoretically as for accounting is concerned.
However, it is used to arrive at efficient economic value.
• Face value. It is price paid to purchase it.
• Insurance value. It is the net replacement cost, keeping in mind depreciated condition of the
asset.
• Potential Value. It is the value of an asset could fetch if sold in open market at a later date due
to potentiality.
• Assessed Value. Value of machinery realized on sale when its useful span of life is over, but
has not become useless.
• Scrap or Junk Value. Vale of any asset particularly that of a machine, realized when it
becomes absolutely useless except for sale as junk.
• Earning value. It is the present value of a property, which will start yielding an income in the
future.

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• Distress value. When a property is sold at a lower price than that which can be obtained for it
in an open market.
Essential Characteristics of Market value
• The essential characteristic for any asset for market value are;
o Vender must be willing to sell.
o Purchaser must be willing to purchase and must be a prudent one who can put the land to
the most beneficial use.
o No compulsion on either in the transactions.
o Urgent necessity to purchase or sale to be discarded.
o Disinclination of vendor to be ignored.
o Sentimental value to the vendor will have place.
o Present and future uses known as potentials are to be taken into account.
Essential Requirements for valuer
• The essential requirements for a genuine valuer are:
o He must have thorough knowledge of estimation of cost and materials.
o He must have knowledge of latest know how of construction materials and construction
techniques.
o He must have knowledge of various laws and acts such as lease policy, land acquisition,
and town planning etc.
o He must be able to make on organized study of the best available information on the subject
of valuation.
o He must accept the responsibility as valuer and must adhere to the standard of excellence.
o He must not be biased and at the same time must have ethical sense.
o Valuation work demands a professional skill.
Object of valuation
• The main objects of valuation are:
o When a seller wants to sell his property or when a purchaser wishes to purchase property.
o When a property is to be rented; its valuation is required.
o It becomes essential to valuate the property for fixation of different types of taxes.
o For insurance property; the premium depends on its value.
o When a government acquires a private property in the interest of public; its compensation
is given to the owner.

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o When a person wants a loan against the security of his asset, it is called a mortgage loan.
o Reinstatement- In case property owner wishes to reinstate his property, the valuation of
asset becomes essential
o Sometime a property has future secret prospects;
o For partition or dissolution of firms.
o To find depreciation value of an asset.
o When two different companies decide to amalgamate, or one company takes over the
business of the other.
o Valuation is also essential if a property is required to be liquidated.
Factors affecting value of an asset
• The value of an asset depends on many factors:
o Price Index: present market rate of various material, labor, machinery etc. must be known
to a valuer.
o Location of property affects a lot on value of that property.
o Demand and supply also affect the value of property.
o Return that can be fetched from the property.
o Useful remaining life of that asset
o Functional use value, flexibility utility i.e. possibility of alterations of its occupancy also
affect its value.
o Neighborhood conditions.
o Local bylaws restricting addition, alteration of building
o Outlook and elevation of building
o Space utilization and service.
5.7. Types of Valuation
• There are various types of valuation;
1. Ordinary valuation
• In ordinary exchange of property; the value is determined by the judgment of the seller and the
buyer, each taking into account the knowledge of the property, the prevailing exchange
conditions, etc.
2. Formal Valuation
• In formal valuation of property, the value is determined by judgment of specially qualified
valuators.
• Such valuation may be for sue in property sell or for many other purposes, such as taxing
property, securing loans, determining rents and establishing fair commodity prices.

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3. Engineering valuation
• It is the art of estimating the value of specific properties where professional engineering
knowledge on and judgment are essential
5.8. Method of Valuation
• The methods available to evaluate many property are given below.
i. Valuation from life i.e. present book value.
ii. Rental method of valuation
iii. Land and building method
iv. Evidence method based on comparison tendencies also called comparable sales
method.
v. Reproduction cost method
vi. Global valuation method
vii. Breakup value method
• A valuer prior to valuing any property must examine and collect the following details:
o Location of property with reference to road width, its frontage etc.
o Shape and size of property.
• A valuer prior to valuing any property must examine and collect the following details:
o Location of property with reference to road width, its frontage etc.
o Shape and size of property.
o Whether owned by singly or co-owner property particularly the plot.
o Whether lease hold free hold.
o Restrictions of local byelaws for leasehold converted to free hold.
o Permissible maximum construction thereon.
o Whether commercial, residential or industrial.
o Restriction of sale or lease deed if any.
o Land rates fixed by authorities.
o Whether earlier registered documents contain provision for grant of sale permissible prior
to sale.
o Sale transactions for that particular type of land during the years to arrive to some realistic
value.
o Whether any easement right exists.
o Probable future development of that locality under consideration.

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Contract, Specification and Quantity surveying Chapter 5

o Any other information available regarding the land such as filled up land, logged land etc.
regarding the building its year of construction, future expected life, etc.
o Whether all the taxes are paid till the date of valuation.
1. Valuation from life
• This method is generally used for equipments but also used for buildings in general.
• In this method depreciated value of asset is calculated assuming that the cost of the building
consists of both building and land.
• Depreciation. Whenever any machine, equipment or a building performs useful work its wear
and tear is bound to occur. This can be minimized up to some extent by proper care and
maintenance but can’t be totally prevented.
• Obsolescence. is the depreciation of existing machinery or asset due to new and better
invention, design of equipment of processes etc.
• This method is generally used for equipments but also used for buildings in general.
• In this method depreciated value of asset is calculated assuming that the cost of the building
consists of both building and land.
• Depreciation. Whenever any machine, equipment or a building performs useful work its wear
and tear is bound to occur. This can be minimized up to some extent by proper care and
maintenance but can’t be totally prevented.
• Obsolescence. is the depreciation of existing machinery or asset due to new and better
invention, design of equipment of processes etc.
• Methods of Depreciation Calculation: The following are the methods for calculating
depreciation.
i. Straight line Methods
ii. Diminishing Balance Method
iii. Sinking fund Method
iv. Annuity Charging method
v. The Insurance policy method
vi. The Revaluation or Regular Valuation method
vii. Machine Hour Basis method
viii. The sum of the year’s Digits method

Straight Line Method

• This method assumes that the loss of value of machine is directly proportional to its age. It
means one should deduct the scrap value from the original value and divide the remaining
value by the number of years of useful life.
Let C, be the Initial cost of a machine.
S, be the scrap value.
N, be the Number of years of life of machine. and
D, be the depreciation amount per year.

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Contract, Specification and Quantity surveying Chapter 5

Example-1
(a) A machine was purchased for Birr 450,000 on 1st January, 1991, the erection and
installation work costs Birr 70,000. This was replaced by a new one on 31st Dec, 2010. If
the Scrap Value was estimated as Birr 150,000 what should be the rate of depreciation
and depreciation fund on 15th June, 2000?
(b) If after 12 years of running, some assemblies are replaced and the replacement cost is
Birr 150,000 what will be the new rate of depreciation?
Solution

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Example-2
Consider an excavator purchased for 3.1 million birr having a useful life of 5 yrs. Determine the
depreciation and book value for each of the 5 years using Straight Line method. Assume a
salvage value of S = 860,000 birr.
Solution

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Instructors: - Ayele Mandefro, Biruk Tibebu and Mikias Alemu
Contract, Specification and Quantity surveying Chapter 5

Diminishing Balance Method

• This is also called “Reducing Balance” Method. The diminishing value of machine is greater
in the early years. It depreciates rapidly in the early and later-on slowly.
• So, under this method, the book value of the machine goes on decreasing as its existence
continues.
• In this, let x be the fixed percentage taken to calculate the yearly depreciation on the book
value.

Where, C = initial cost, S = Scrap Value, N=No. of the years of life.

• It will be more clear by the following solved example.
Example - 3
A lathe is purchased for Birr 800,000 and the assumed life is 10 years and scrap value Birr
200,000. If the depreciation is charged by diminishing Balance method, calculate the percentage
by which value of the lathe is reduced every year and depreciation fund after 2 years.

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Instructors: - Ayele Mandefro, Biruk Tibebu and Mikias Alemu
Contract, Specification and Quantity surveying Chapter 5

Solution

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Instructors: - Ayele Mandefro, Biruk Tibebu and Mikias Alemu
Contract, Specification and Quantity surveying Chapter 5

2. Rental Method of Valuation (Capitalized Income Method)

• This method is used for big premises like flats, hotels, and hostels, offices from which income
can be produced or likely to be produced from the property.
• This method consists of ascertaining net rent per annum from the asset and multiplying this to
years purchase. The procedure consists of:
o To find out gross rent likely to be received from the asset.
o To find out goings i.e. deduction: These are expenses incurred on the asset in the form of
taxes, insurances, etc.
o To decide present value of birr per annum received in perpetuity i.e. Y.P. bases on
required rate of interest.
o To asses values of property by multiplying net income per annum to Y.P.
3. Land and Building Method of valuation.
• In this method the valuation of land and part building constructed over it are made separately
and the value of that asset is made by adding them.
• If building does not exist then only land is evaluated.
• Some of the points that need to be carefully seen in the valuation are:

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Contract, Specification and Quantity surveying Chapter 5

o Recent sale instances of land in the neighborhood.

o Income yielding capacity and state of the money market.
o Value depends on supply and demand.
o Land value generally appreciate with time.
o Land value is based on the most advantageous way in which the land can be put to use.
o In case of lease hold land, all restrictions imposed on the use of the land to be taken into
account.
• In this method the valuation of land and part building constructed over it are made separately
and the value of that asset is made by adding them.
• If building does not exist then only land is evaluated.
• Some of the points that need to be carefully seen in the valuation are:
o Recent sale instances of land in the neighborhood.
o Income yielding capacity and state of the money market.
o Value depends on supply and demand.
o Land value generally appreciate with time.
o Land value is based on the most advantageous way in which the land can be put to use.
o In case of lease hold land, all restrictions imposed on the use of the land to be taken into
account.
• The factors that affect the value of an asset in valuation by land and building method are listed
below:
1. The valuation of land is based on its utility. This utility is affected by various factors such
as: Floor, shape of land, Frontage/depth ratio
2. Situation of property: a locality based on its use can be classified as: residential,
commercial, industrial or mixed.
3. Size of plot or land is also one of the factors.
4. Restriction on transfer of land.
5. Land cost is affected by urban land ceiling.
6. Return frontage or end plots.
7. Vista land having a front road.

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Instructors: - Ayele Mandefro, Biruk Tibebu and Mikias Alemu